Innovation under Competition
Week 5
Innovation under Competition
Trade-Off R&D
Chance of innovation with promising returns
Risk of losing R&D investments
If no success at all If other company is faster
Set-Up
Pharmaceutical companies (A and B)
Have to decide whether to engage in R&D for a new drug against asthma
Fixed costs for R&D activity of £ 10mn
With likelihood p they come up with a marketable innovation
Profits from innovation
• £ 24mn if alone on the market • £ 10mn if with a competitor on the market
Payoffs for Company A
Company A engages in R&D, company B does not
Both companies engage in R&D
Company A does not engage in R&D
Payoff Matrix Firm B
Firm A
No R&D No R&D
R&D
0/0
24p - 10 / 0
R&D 0 / 24p - 10 24p (1-p) + 10p2 - 10 / 24p (1-p) + 10p2 - 10 in £ mn
Low Success Rate Likelihood p that R&D generates innovation = 0.25
Firm B
Firm A
No R&D No R&D
R&D
0/0
24p - 10 / 0
R&D 0 / 24p - 10 24p (1-p) + 10p2 - 10 / 24p (1-p) + 10p2 - 10 in £ mn
Low Success Rate Likelihood p that R&D generates innovation = 0.25
Firm B
Firm A
No R&D
R&D
No R&D
0/0
0 / -4
R&D
-4 / 0
-4.875 / -4.875 in £ mn
Medium Success Rate Likelihood p that R&D generates innovation = 0.5
Firm B
Firm A
No R&D No R&D
R&D
0/0
24p - 10 / 0
R&D 0 / 24p - 10 24p (1-p) + 10p2 - 10 / 24p (1-p) + 10p2 - 10 in £ mn
Medium Success Rate Likelihood p that R&D generates innovation = 0.5
Firm A
Firm B No R&D
R&D
No R&D
0/0
0/2
R&D
2/0
-1.5 / -1.5 in £ mn
High Success Rate Likelihood p that R&D generates innovation = 0.75
Firm B
Firm A
No R&D No R&D
R&D
0/0
24p - 10 / 0
R&D 0 / 24p - 10 24p (1-p) + 10p2 - 10 / 24p (1-p) + 10p2 - 10 in £ mn
High Success Rate Likelihood p that R&D generates innovation = 0.75
Firm B
Firm A
No R&D
R&D
No R&D
0/0
0/8
R&D
8/0
0.125 / 0.125 in £ mn
Comparison of Success Rates
Low success rate
No R&D at all
Medium success rate
R&D by one firm and pre-emption
High success rate
R&D by both firms
Competitive Strategy Tobias Kretschmer Professor of Management, LMU Munich
© 2013 LMU Munich
Innovation under Competition
Trade-Off R&D
Chance of innovation with promising returns
Risk of losing R&D investments
If no success at all If other company is faster
Set-Up
Pharmaceutical companies (A and B)
Have to decide whether to engage in R&D for a new drug against asthma
Fixed costs for R&D activity of £ 10mn
With likelihood p they come up with a marketable innovation
Profits from innovation
• £ 24mn if alone on the market • £ 10mn if with a competitor on the market
Payoffs for Company A
Company A engages in R&D, company B does not
Both companies engage in R&D
Company A does not engage in R&D
Payoff Matrix Firm B
Firm A
No R&D No R&D
R&D
0/0
24p - 10 / 0
R&D 0 / 24p - 10 24p (1-p) + 10p2 - 10 / 24p (1-p) + 10p2 - 10 in £ mn
Low Success Rate Likelihood p that R&D generates innovation = 0.25
Firm B
Firm A
No R&D No R&D
R&D
0/0
24p - 10 / 0
R&D 0 / 24p - 10 24p (1-p) + 10p2 - 10 / 24p (1-p) + 10p2 - 10 in £ mn
Low Success Rate Likelihood p that R&D generates innovation = 0.25
Firm B
Firm A
No R&D
R&D
No R&D
0/0
0 / -4
R&D
-4 / 0
-4.875 / -4.875 in £ mn
Medium Success Rate Likelihood p that R&D generates innovation = 0.5
Firm B
Firm A
No R&D No R&D
R&D
0/0
24p - 10 / 0
R&D 0 / 24p - 10 24p (1-p) + 10p2 - 10 / 24p (1-p) + 10p2 - 10 in £ mn
Medium Success Rate Likelihood p that R&D generates innovation = 0.5
Firm A
Firm B No R&D
R&D
No R&D
0/0
0/2
R&D
2/0
-1.5 / -1.5 in £ mn
High Success Rate Likelihood p that R&D generates innovation = 0.75
Firm B
Firm A
No R&D No R&D
R&D
0/0
24p - 10 / 0
R&D 0 / 24p - 10 24p (1-p) + 10p2 - 10 / 24p (1-p) + 10p2 - 10 in £ mn
High Success Rate Likelihood p that R&D generates innovation = 0.75
Firm B
Firm A
No R&D
R&D
No R&D
0/0
0/8
R&D
8/0
0.125 / 0.125 in £ mn
Comparison of Success Rates
Low success rate
No R&D at all
Medium success rate
R&D by one firm and pre-emption
High success rate
R&D by both firms
Competitive Strategy Tobias Kretschmer Professor of Management, LMU Munich
© 2013 LMU Munich
